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Advice on the countercyclical capital buffer 2015 Q2

Norges Bank's letter of 17 June 2015 to the Ministry of Finance.

Norges Bank is responsible for preparing a decision basis and advising the Ministry of Finance on the level of banks' countercyclical capital buffer four times a year. On 27 March 2015, the Ministry of Finance decided to keep the buffer rate unchanged at 1 percent, in line with Norges Bank's advice. The rate is effective from 30 June 2015. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2015 Q2 is presented in the June 2015 Monetary Policy Report.

The premise for Norges Bank's assessment is that banks should build up and hold a countercyclical capital buffer when financial imbalances are building up or have built up. The buffer rate will be assessed in the light of other requirements applying to banks. The buffer rate can be reduced in the event of an economic downturn and large bank losses with a view to mitigating the procyclical effects of tighter bank lending. The buffer rate should not be reduced automatically even if there are signs that financial imbalances are receding. The countercyclical capital buffer is not an instrument for fine-tuning the economy.

Banks posted solid earnings in 2015 Q1 and continued to build capital. At the end of Q1, the average Common Equity Tier 1 (CET1) ratio for the largest banks was 12.8 percent. This is higher than the capital requirements applicable from 1 July 2015. The capital requirement for systemically important banks will increase further in 2016. Banks are well positioned to meet the higher requirements.

Norges Bank's assessment of financial imbalances is based, among other things, on the credit-to-GDP ratio and its deviation from a long-term trend. Overall credit to enterprises and households is at a high level relative to mainland GDP. In the post-crisis years, credit growth has decreased, but credit has continued to expand somewhat faster than GDP. Growth in corporate debt has been fairly low in recent years. Growth in bank lending to enterprises has increased a little recently, particularly to enterprises in the commercial property sector and construction. Household debt is rising faster than disposable income.

The European Systemic Risk Board (ESRB) recommends the calculation of technical benchmark buffer rates. The long-term trend in the credit indicator can be calculated by applying different methods. Applying the trend calculation method proposed by the Basel Committee on Banking Supervision, the benchmark buffer rate was 0 percent in 2015 Q1. Using an alternative trend calculation method, which has been shown to provide a better leading indicator of crises, the reference rate was 1 percent. The ESRB stipulates that there should not be a mechanical relationship between the benchmark rate and the buffer rate, but that the requirement should be based on a broader decision basis.

In addition to the credit indicator, Norges Bank takes account of developments in property prices and banks' wholesale funding ratios. House prices rose sharply in autumn 2014, but house price growth has slowed slightly in recent months. The commercial property price indicator rose markedly through 2014. Banks' wholesale funding ratios have recently edged up a little.

The persistent rise in household debt indicates that household sector financial imbalances are on the rise. Overall corporate debt growth is moderate, but in the commercial property sector, debt growth has recently moved up. The implementation of prudent mortgage lending standards for banks as regulatory requirements and weaker growth in the Norwegian economy may help curb household debt accumulation. On the other hand, even lower lending rates may fuel further growth in property prices and debt.

The largest banks are well positioned to meet the capital requirements applicable as from mid-2016. More capital will strengthen banks' resilience to future loan losses.

Based on an overall assessment, Norges Bank's Executive Board decided to advise the Ministry of Finance to increase the buffer rate to 1.5 percent with effect from summer 2016.

Under the regulation on the countercyclical capital buffer, Norges Bank is also required to issue advice on the extent to which Norwegian financial institutions should meet the countercyclical buffer requirement for that portion of their activities carried out in another country. The authorities in several EU/EEA countries have set countercyclical buffer rates. Norges Bank recommends that these rates apply to Norwegian banks' exposures in the relevant countries.

In preparing its advice on the countercyclical capital buffer, Norges Bank has exchanged information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway).